Monday, August 3, 2009

Short- and Long-Term Complexities for Equity Investors

The Matrix, but with money: The world of high-speed trading by John Stokes on Ars Technica is an interesting look at how global equity markets are dominated by computerized high-frequency trading, or HFT. According to the article, 60 to 75 percent of all trading may be done by computers, while only three percent of all trading is "open outcry", i.e. traders yelling and gesturing on the floor of an exchange. The rest of the trades are routed through electronic communication networks, or ECNs.

HFT involves executing rapid-fire trades in order to earn small profits on each one, and multiplying those profits with high volumes. Experts estimate that HFT generated $20 billion in profit for the financial sector last year, with Goldman Sachs responsible for 20% of the volume. Some investment funds use HFT exclusively. Stokes provides some examples of HFT approaches, including "iceberging", "predatory algos". "statistical arbitrage", and "dark pools". He also discusses the importance of superior relative system performance through optimized software and the latest hardware. Some of these techniques are controversial, with their advocates claiming that they ensure liquidity, but their detractors claiming that they amount to manipulation.

On the other hand, some researchers assert that Now the Long Run Looks Riskier, Too. Mark Hulbert's March article in the New York Times says that while the returns on equities have been superior to other asset classes and remarkably consistent over the past two centuries, projecting those returns forward over future decades could be quite risky due to factors without precedent, such as global warming and the potential occurrences and outcomes of future wars.

How do you view short-term versus long-term equity market volatility? How do your views affect your behavior as an investor?

No comments:

Post a Comment